Brexit could trigger the next financial crisis — in Italy

Italian banks are sitting on a heap of bad loans — and Britain just voted to throw a match onto the pile.

A full 17 percent of loans held by Italian banks have turned sour, The Wall StreetJournal reports. At the height of the 2008 financial crisis that figure never exceeded 5 percent for U.S. banks. In total, Italian banks are holding on to €360 billion in impaired loans — quadruple their 2008 level.

To stabilize its financial system, the Italian government has sought the European Union's permission to channel €40 billion of taxpayer funds into its banks. But the other EU leaders are giving Italy the red light. In deference to populist outrage over the postcrisis bank bailouts, the bloc adopted a rule in 2014 that requires a troubled bank's stakeholders — shareholders, bondholders, certain depositors — to take a financial hit before taxpayers are asked to open their wallets.

But in Italy, an unusually high percentage of those stakeholders are individual investors, many of them elderly. These aren't well-heeled speculators who can foot the bill by auctioning off their second yachts. When four small Italian banks fell into crisis last year, 100,000 Italian investors saw their holdings erased. A national controversy ensued following reports that a retiree committed suicide after losing €110,000 in savings. At present, retail investors hold roughly €187 billion in Italian bank bonds. If those investors see large swaths of their savings wiped out, it could take down Italian prime minister Matteo Renzi's government.

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Two activists with the EU flag and Union Jack painted on their faces kiss each other in front of Brandenburg Gate to protest against British exit from the European Union, in Berlin, Germany, June 19, 2016. REUTERS/Hannibal Hanschke

A protestor uses a megaphone to address a crowd as they gather outside The Houses of Parliament to demonstrate against the European Union (EU) referendum result, in London, U.K., on Saturday, June 25, 2016. The U.K. voted to quit the European Union after more than four decades in a stunning rejection of the continent's postwar political and economic order. Photographer: Jason Alden/Bloomberg via Getty Images

A protestor holds a placard which reads 'YES 2 EU' to demonstrate against the European Union (EU) referendum result, outside The Houses of Parliament in London, U.K., on Saturday, June 25, 2016. The U.K. voted to quit the European Union after more than four decades in a stunning rejection of the continent's postwar political and economic order. Photographer: Jason Alden/Bloomberg via Getty Images

A protestor holding a European Union (EU) flag, addresses a crowd as he demonstrates against the European Union (EU) referendum result, in London, U.K., on Saturday, June 25, 2016. The U.K. voted to quit the European Union after more than four decades in a stunning rejection of the continent's postwar political and economic order. Photographer: Jason Alden/Bloomberg via Getty Images

A protest camp of people calling for a second referendum on Scottish independence, in Edinburgh, Scotland on June 25, 2016, following the pro-Brexit result of the UK's EU referendum vote.
The result of Britain's June 23 referendum vote to leave the European Union (EU) has pitted parents against children, cities against rural areas, north against south and university graduates against those with fewer qualifications. London, Scotland and Northern Ireland voted to remain in the EU but Wales and large swathes of England, particularly former industrial hubs in the north with many disaffected workers, backed a Brexit. / AFP / OLI SCARFF (Photo credit should read OLI SCARFF/AFP/Getty Images)

A demonstrator holds a placard that reads 'So Long Great Britain' during a protest against the pro-Brexit outcome of the UK's June 23 referendum on the European Union (EU), in central London on June 25, 2016.
The result of Britain's June 23 referendum vote to leave the European Union (EU) has pitted parents against children, cities against rural areas, north against south and university graduates against those with fewer qualifications. London, Scotland and Northern Ireland voted to remain in the EU but Wales and large swathes of England, particularly former industrial hubs in the north with many disaffected workers, backed a Brexit. / AFP / JUSTIN TALLIS (Photo credit should read JUSTIN TALLIS/AFP/Getty Images)

A demonstrator holds a placard during a protest against the pro-Brexit outcome of the UK's June 23 referendum on the European Union (EU), in central London on June 25, 2016.
The result of Britain's June 23 referendum vote to leave the European Union (EU) has pitted parents against children, cities against rural areas, north against south and university graduates against those with fewer qualifications. London, Scotland and Northern Ireland voted to remain in the EU but Wales and large swathes of England, particularly former industrial hubs in the north with many disaffected workers, backed a Brexit. / AFP / JUSTIN TALLIS (Photo credit should read JUSTIN TALLIS/AFP/Getty Images)

LONDON, ENGLAND - JUNE 25: A small group of young people gather to protest on Parliament Square the day after a majority of the British public voted for leaving the European Union on June 25, 2016 in London, England. The ramifications of the historic referendum yesterday that saw the United Kingdom vote to Leave the European Union are still being fully understood. The Labour leader, Jeremy Corbyn, who is under pressure from within his party to resign has blamed the 'Brexit' vote on 'powerlessness', 'austerity' and peoples fears over the issue of immigration. (Photo by Dan Kitwood/Getty Images)

LONDON, ENGLAND - JUNE 25: A small group of young people gather to protest on Parliament Square the day after a majority of the British public voted for leaving the European Union on June 25, 2016 in London, England. The ramifications of the historic referendum yesterday that saw the United Kingdom vote to Leave the European Union are still being fully understood. The Labour leader, Jeremy Corbyn, who is under pressure from within his party to resign has blamed the 'Brexit' vote on 'powerlessness', 'austerity' and peoples fears over the issue of immigration. (Photo by Dan Kitwood/Getty Images)

LONDON, ENGLAND - JUNE 25: A small group of people gather to protest on Parliament Square the day after the majority of the British public voted to leave the European Union on June 25, 2016 in London, England. The ramifications of the historic referendum yesterday that saw the United Kingdom vote to Leave the European Union are still being fully understood. The Labour leader, Jeremy Corbyn, who is under pressure from within his party to resign has blamed the 'Brexit' vote on 'powerlessness', 'austerity' and peoples fears over the issue of immigration. (Photo by Matt Cardy/Getty Images)

LONDON, ENGLAND - JUNE 25: A small group of young people gather to protest on Parliament Square the day after a majority of the British public voted for leaving the European Union on June 25, 2016 in London, England. The ramifications of the historic referendum yesterday that saw the United Kingdom vote to Leave the European Union are still being fully understood. The Labour leader, Jeremy Corbyn, who is under pressure from within his party to resign has blamed the 'Brexit' vote on 'powerlessness', 'austerity' and peoples fears over the issue of immigration. (Photo by Dan Kitwood/Getty Images)

Demonstrators hold placards during a protest against the outcome of the UK's June 23 referendum on the European Union (EU), in central London on June 25, 2016.
The result of Britain's June 23 referendum vote to leave the European Union (EU) has pitted parents against children, cities against rural areas, north against south and university graduates against those with fewer qualifications. London, Scotland and Northern Ireland voted to remain in the EU but Wales and large swathes of England, particularly former industrial hubs in the north with many disaffected workers, backed a Brexit. / AFP / JUSTIN TALLIS (Photo credit should read JUSTIN TALLIS/AFP/Getty Images)

LONDON, ENGLAND - JUNE 25: A small group of people gather to protest on Parliament Square the day after the majority of the British public voted to leave the European Union on June 25, 2016 in London, England. The ramifications of the historic referendum yesterday that saw the United Kingdom vote to Leave the European Union are still being fully understood. The Labour leader, Jeremy Corbyn, who is under pressure from within his party to resign has blamed the 'Brexit' vote on 'powerlessness', 'austerity' and peoples fears over the issue of immigration. (Photo by Dan Kitwood/Getty Images)

LONDON, ENGLAND- JUNE 24: Young protesters demonstrate outside Downing Street, following the United Kingdom's decision to leave the EU following the referendum, on June 24, 2016 in London, England. The result from the historic EU referendum has now been declared and the United Kingdom has voted to LEAVE the European Union. (Photo by Mary Turner/Getty Images)

A boat flying a large 'In' flag, campaigning to remain in the EU in the upcoming referendum sails by the British Houses of Parliament to meet a flotilla of boats from the group 'Fishing for Leave' on the river Thames in London on June 15, 2016.
A Brexit flotilla of fishing boats sailed up the River Thames into London today with foghorns sounding, in a protest against EU fishing quotas by the campaign for Britain to leave the European Union. / AFP / NIKLAS HALLE'N (Photo credit should read NIKLAS HALLE'N/AFP/Getty Images)

A boat flying a large 'In' flag, campaigning to remain in the EU in the upcoming referendum sails by the British Houses of Parliament to oppose a flotilla of boats from the group 'Fishing for Leave' (L) on the river Thames in London on June 15, 2016.
A Brexit flotilla of fishing boats sailed up the River Thames into London today with foghorns sounding, in a protest against EU fishing quotas by the campaign for Britain to leave the European Union. / AFP / NIKLAS HALLE'N (Photo credit should read NIKLAS HALLE'N/AFP/Getty Images)

A boat carrying supporters for a ' remain' vote in the EU referendum including Irish singer Bob Geldof (C) shout and wave at fishing boats supporting a 'leave' vote as they sail on the river Thames in central London on June 15, 2016.
A Brexit flotilla of fishing boats sailed up the River Thames into London today with foghorns sounding, in a protest against EU fishing quotas by the campaign for Britain to leave the European Union. / AFP / NIKLAS HALLE'N (Photo credit should read NIKLAS HALLE'N/AFP/Getty Images)

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This is where Italy was before the British went to the polls on June 23. After 52 percent of the U.K. voted to leave the EU, the nation's financial headache has bloomed into a migraine.

Brexit hurts Italy's banking system in at least three ways. First, the uncertainty unleashed by the referendum will likely slow growth across the continent. Italy's business lobby group Confindustria has already revised the nation's 2016 growth forecast downward. Slower growth could cause even more bad loans to pile up in Italian banks.

Second, Europe's central banks are expected to respond to flagging growth by keeping interest rates low, thus decreasing the profitably of the bloc's banks. Since the Brexit vote, an index of European banks has dropped 17 percent. Italy's banks have long been among the least profitable in Europe, and, as the Journal notes, they're especially vulnerable to the squeeze of low interest rates — unlike their peers in the U.S. and U.K., Italian banks perform little in the way of fee-generating services like asset management and investment banking.

Finally, one of Italy's largest banks, Banca Monte dei Paschi di Siena, is trying to sell off a giant package of bad loans to a foreign partner. Several bankers tell the Journal that the uncertainty kicked up by the Brexit vote will make that sale far more difficult.

If Italy's banking system falls into full-blown crisis, it could have ripple effects, both economic and political. The nation will hold a referendum on a package of constitutional reforms no later than October. In a recent note, Citibank described that referendum as "the single biggest risk on the European political landscape this year among non-UK issues." If a weakened economy inspires Italian voters to reject the reforms backed by Prime Minister Renzi, it would empower the country's own Euroskeptic party, the Five Star Movement, and force the word "Italexit" into everyone's vocabulary.

"There is an epidemic, and Italy is the patient that is sickest," Pier Paolo Baretta, an undersecretary at the Italian Economy Ministry, told the Journal. "[If] we don't stop the epidemic, it will become everybody's problem ... The shock of Brexit has created a sense of urgency."